Taxation Laws Amendment Bill (No. 7) 2002

Bills Digest No. 68 2002-03

Taxation Laws Amendment Bill (No. 7) 2002

WARNING:
This Digest was prepared for debate. It reflects the legislation as
introduced and does not canvass subsequent amendments. This Digest
does not have any official legal status. Other sources should be
consulted to determine the subsequent official status of the
Bill.

The provisions in the current Bill regarding the
taxation treatment of foreign expatriates or temporary residents
were debated by the Parliament as part of Taxation Laws
Amendment Act (No. 4) 2002. On 27 June the Senate amended the
Bill to that Act by deleting the provisions relating to temporary
residents.(1) The House of Representatives agreed to the
Senate amendment later the same day.

With the exception of minor changes, the
provisions in the current Bill relating to temporary residents are
identical to those in Taxation Laws Amendment Bill (No. 4) 2002
(see Bills Digest
No. 179 2001-02 for earlier commentary).

The current Bill:

provides a tax exemption to temporary
residents(2) for a maximum period of 4 years for all
foreign source income and capital gains not associated with
Australian employment or service;

gives temporary residents an exemption for a similar
period from interest withholding tax obligations,(3)
and

removes the current time limit of 4 years on
exemptions from Foreign Investment Fund (FIF) rules(4)
for all holders of temporary visas.(5)

The explanatory memorandum to the Bill states
that the exemption for temporary residents measure:

seeks to attract internationally skilled mobile
labour to Australia. It also seeks to assist in the promotion of
Australia as a business location, by reducing the costs to
Australian business of bringing skilled expatriates to work in
Australia.(6)

In a related step, the Government amended the
Superannuation Industry (Supervision) Regulations and the
Retirement Savings Account Regulations in May 2002 to
allow temporary residents to access their Australian superannuation
on permanent departure from this country.

As noted in Bills Digest No. 179 200102, income
tax relief for people working in Australia on temporary entry visas
was recommended in the 1999 Review of Business Taxation A Tax
System Redesigned (Ralph Report). The Ralph Report observed
that a new Australian Tax Office ruling:

may have led to more foreign expatriates, such
as executives, becoming residents for tax purposes. As many
employers agree to pay tax on expatriates behalf, the ruling may
result in higher costs to businesses wishing to employ
expatriates.(7)

The Ralph Report recommendation that tax
exemptions for expatriates only apply in relation to pre-residence
assets and liabilities has been extended by the Government to apply
to foreign source income and interest withholding tax obligations
regardless of whether the relevant asset or liability was acquired
before or after the expatriate took up residency in Australia. As
the explanatory memorandum notes, this will enable expatriates to
add to or change their overseas sources of income while resident in
this country without incurring Australian income tax:

The extension to the Ralph recommendations
avoids locking temporary residents into pre-residence investments
or financial arrangements for the period of the 4 year
exemption.(8)

Following the exclusion of tax exemptions for
temporary residents from Taxation Laws Amendment Bill (No. 4) 2002,
the Chief Executive of the Business Council of Australia, Ms Katie
Lahey, said that Australias present international tax arrangements
were constraining our participation in the international
economy:

They distort commercial decisions, they are
arbitrary and unnecessarily complex. In the face of a contemporary
wave of rapid change in international tax regimes around the world,
Australias international tax arrangements are becoming even less
competitive.(9)

On 22 August 2002, the Treasurer released the
consultation paper Review of International Taxation
Arrangements, the first major review of Australias
international tax regime since the early 1990s.(10) The
consultation paper is available at the Tax Boards website.(11)

Chapter 5 of the consultation paper Improving
Australias tax treatment of foreign expatriates - refers to the
measures in the current Bill to reduce taxation for expatriates,
arguing that they are consistent with approaches other countries
take.(12) It then proposes a number of additional
measures to further ease the Australian tax burden on such
people.(13) As the Treasurer noted, the thinking behind
such reforms is to improve the tax treatment of foreign expatriates
to enhance Australias attractiveness to overseas
talent.(14)

The Review of International Taxation
Arrangements has been criticised, with one commentator noting
that the suggested reforms in the consultation paper are not placed
within a broad theoretical framework; rather they are a grab bag of
options; and that there is a focus on short-term change rather than
long term policy design.(15)

The deadline for written submissions in response
to the consultation paper was 31 October 2002. The Government has
asked the Taxation Board to report on the outcome of the
consultation process by the end of 2002. Submissions will not be
available publicly until the Board has delivered its report.

According to the Treasurer, the Government will
consider its position on what reforms might be needed once the
Board has reported.(16)

In response to the release of the consultation
paper, Brian Toohey in the Australian Financial Review
commented:

Some of the proposals would seem to violate the
general tax principle that income should be treated equally,
regardless of the identity of the recipient. If the Government
pushes ahead with one change, Australian citizens will be entitled
to ask why a foreign executive working in Australia should pay less
tax than an Australian counterpart.(17)

The Certified Practising Accountants of
Australia reported that in a consultative seminar with the Taxation
Board:

On Chapter 5 issues (improving the tax treatment
of expatriates), it was suggested that any changes here should
ensure equality between permanent and temporary residents,
particularly bearing in mind the current political sensitivities on
this topic. While not a high priority, some thought to do nothing
could send the wrong message to foreign investors It was also noted
that the real problem in this area was Australias high marginal tax
rates.(18)

In contrast, the Business Coalition for Tax
Reform reiterated its support for measures to minimise the
Australian tax levied on non-Australian source income, or gains to
non-residents.(19) Sally Morton from Deloitte Touche
Tohmatsu also supported changes to taxation rules affecting foreign
expatriates, arguing that temporary residents should pay some tax,
but only on an amount that is commensurate with their time in
Australia. According to Morton, the cost of hiring foreign
nationals has been a real impost, particularly in the last two
years.(20)

The explanatory memorandum to the Bill estimates
that the measures will cost between $40 and $50 million per
year.(21)

Item 2 of Schedule 1 will
insert a new paragraph 128B(3)(i) into the
Income Tax Assessment Act 1936 (ITAA36) to exempt
temporary residents from all interest withholding tax obligations
for the duration of the 4 year exemption period.

Item 4 will replace existing
paragraphs 517(2)(b) and (c) of the ITAA36 with a new
paragraph 517(2)(b) that removes the current 4 year time
limit on exemptions from FIF rules for holders of temporary
visas.

Item 9 will insert a
new section 51-52 into the Income Tax
Assessment Act 1997 (ITAA97) to exempt the foreign sourced
income of temporary residents from income tax. The exemption will
not apply to foreign income earned as a result of employment
undertaken or services provided while a temporary resident.

Item 11 will insert a
new section 118-575 into the ITAA97 to exempt
capital gains and losses for temporary residents derived from a
source outside Australia and/or from assets lacking the necessary
connection with Australia. Gains from land and buildings in
Australia, and legal interests in such assets, are outside this
exemption, as are other assets such as shares in Australian
resident private companies. However, shareholdings of less than 10
per cent in Australian public companies, and holdings of less than
10 per cent in resident unit trusts are not classed as having a
necessary connection with Australia and are therefore within the
exemption (see section 136-25 of the ITAA97).

Application: The amendment in Item 2 to exclude
temporary residents from withholding tax obligations applies to
payments of interest made from the date of Royal Assent. The other
provisions affecting taxation of temporary residents apply from 1
July 2002 (item 13).

Comment

It is not clear why the Bill seeks to pre-empt
Government consideration of the Taxation Boards report on the
Review of International Taxation Arrangements, nor why it
includes some only of the measures relating to taxation treatment
of foreign expatriates discussed in the Reviews consultation paper.
It would seem sensible for the Government to determine its overall
strategy for international taxation and within this its policy on
the appropriate tax burden for foreign expatriates - before
presenting individual measures to Parliament. In addition, it would
be useful for Parliament in debating this issue to have access to
public submissions on the Review of International Taxation
Arrangements, and to be able to consider as one package the
proposed measures regarding expatriate taxation.

Where a member of the Australian Defence Force
(ADF) sustains an injury on warlike operations overseas and is
repatriated to Australia, he/she receives compensation for the loss
of an overseas deployment allowance. Under current law, the
deployment allowance is exempt income for the purposes of taxation
but the compensation amount is not.

Similarly, where a member of the Reserve Defence
Forces resigns because of injury sustained during Reserve service,
he/she receives compensation for loss of Reserve Force income.
Under current law, Reserve Force pay and allowances are exempt
income for the purposes of taxation but the compensation amount is
not.

Item 4 of Schedule 2 will
insert new sections 51-32 and 51-33 into the
ITAA97 to provide an income tax exemption for compensation paid for
the loss of the warlike service deployment allowance or Reserve
Force pay and allowances.

There is no provision under current taxation law
allowing retrospective adjustment of earlier tax assessments where
some of the original income amount has to be repaid in later
years.

As the explanatory memorandum notes, the ADF,
for example, pays retention bonuses to encourage servicemen and
women to stay in the armed forces for the whole of an agreed
period. If the ADF member resigns before the end of the agreed
period, he/she has to repay the retention bonus on a pro-rata
basis.(22)

Taxpayers pay income tax on such payments in the
year the payments are received. However where taxpayers have to
make repayments in later years, they may be required to repay the
gross amount ie including an amount for tax already paid or
payable.

Item 1 of Schedule 3 will
insert new subsection 170(10AB) into the ITAA36 to
allow retrospective amendments of income tax assessments despite
the normal time limits (2 or 4 years depending on the class of
taxpayer) for such amendments being exceeded.

Item 4 of Schedule 3 will
insert a new Division 22 into the ITAA97 treating
previously assessable income as not assessable if it has to be
repaid in later years.

The explanatory memorandum states that the
Commonwealth Games Federation an unincorporated association based
in the United Kingdom - will be given a tax exemption for the
purpose of organising and promoting the staging of the Commonwealth
Games. It is envisaged that the exemption will apply principally in
respect of payments to the Federation from the organising committee
for the 2006 Melbourne Commonwealth Games in relation to the sale
of television broadcasting rights.(25)

Despite the wording of the explanatory
memorandum, Item 3 of Schedule 5 does not limit
the exemption either to income derived by the Federation for the
purpose stated in the explanatory memorandum, or to income the
Federation receives from the organising committee for the 2006
Games.

Item 3 of Schedule 5 will amend
section 50-45 of the ITAA 97 to provide an income
tax exemption for the Commonwealth Games Federation for the period
1 January 2000 to 30 June 2007.

An ALP amendment to this effect was supported by the Greens and
the Democrats. The ALP position, as stated by Senator Conroy, was
that we do not believe it is an appropriate use of taxpayers funds
to give this sort of tax break to foreign executives, particularly
given their somewhat colourful and successful regimes that run some
of our larger public companies. (Senate Hansard, 27 June 2002, p.
2982).

Under item 12 of Schedule 1, to qualify as a temporary resident
for the purpose of income tax assessment, a person cannot have been
a resident of Australia within the last 10 years. If a person stays
more than 4 years in Australia, they cease to be a temporary
resident.

Under section 128B(2) of the Income Tax Assessment Act
1936, Australian residents who pay interest to overseas
lending institutions are obliged to "withhold" a certain percentage
of the interest as tax payable to the Australian Government. The
rate depends on the country in which the lending institution is
based, but is usually 10 per cent. Under section 255, Australian
residents are personally liable for any amounts they fail to
withhold.

Under FIF rules, Australian taxpayers must pay tax on income
and gains from non-Australian controlled overseas companies,
foreign trusts or foreign life insurance policies with an
investment component.

As the explanatory memorandum notes at p. 20, this measure not
only applies to temporary residents but also to others who enter
Australia under the economic, international and social/cultural
visa streams, as well as those on student visas and New Zealanders
who do not intend to stay permanently in Australia.

Australian Financial Review, 24 August 2002. Whether an
Australian executive would pay more tax depends, of course, on
whether such a person has overseas investments and other sources of
foreign income. The specific terms of Double Taxation Agreements
with particular countries may also affect the relative amounts of
tax payable.

Peter Prince
25 November 2002
Bills Digest Service
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ISSN 1328-8091
Commonwealth of Australia 2002

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